Municipal Bond Fund 'Swan Dive'

Oct.14.09 | About: Nuveen Select (NXR)

Investors have traditionally bought municipal bond funds for income purposes. The tax-exempt status provides real appeal and the default rate on municipals has always been exceptionally low. Against that backdrop, ‘munis’ have always proven to be less volatile than equities and many other sectors of the bond market . . . until now.

If a picture tells a thousand words, this graph of a Nuveen National Municipal Closed End Fund (NYSE:NXR) is more than a short story. From the Sense on Cents link to The Wall Street Journal’s Market Data page, we learn:

That cliff-like drop on the right side of the graph represents approximately a 7% decline in the value of this specific fund culminating in a precipitous 5% drop just yesterday. Part of the decline is explained by the fact that yesterday this fund traded “ex-dividend,” meaning that investors who purchased the fund yesterday are not in line to receive the October dividend. That dividend represents a minor part of the overall decline in the value of this fund.

What does the decline truly represent? The fact that bonds in this $185 million fund declined in value. Why would that happen? The municipalities which had issued these bonds are likely having problems refinancing their debt. What does that mean? Those municipalities will be forced to pay higher rates. And what does that mean? Their outstanding bonds, such as those in this national fund, decline in value. Additionally, the higher rates mean the municipalities will remain hard pressed not to cut services and employees.

Keep your brokers and financial planners honest and compel them to fully explore the credit quality of investments (whether bonds or equities) prior to investing. Otherwise, picture yourself as having invested in this fund a month ago and now eating a 7% loss as you take a ’swan dive’ off the right side of the above graph.

Disclosure: No position in NXR